What Is an FHA Loan?

Author  Lorien Strydom

Editor  Abraham Jimoh

Last updated: December 16, 2024

If you are looking to buy a home but you don’t have a big down payment, and FHA loan may be the answer. FHA loans are insured by government and therefore they come with a few benefits.

Let’s dive deeper into FHA loans and explain how they work.

What Is an FHA Home Loan?

An FHA mortgage is a mortgage that is insured by the Federal Housing Administration (FHA). his premium is required on all FHA loans and is typically 1.75% of the l

FHA loans are designed to help first-time homebuyers and those with lower credit scores or limited down payment funds to purchase a home.

• With the FHA loan program, borrowers can have down payments of only 3.5% of the property’s purchase price. This is lower than the typical down payment requirement of 20% for conventional loans.

• FHA loans are more flexible in terms of credit scores, making it easier for borrowers with lower credit scores to qualify.

• FHA loans come in several types, including fixed-rate and adjustable-rate mortgages.

Read more: Fixed-rate vs adjustable-rate mortgage

Borrowers must pay an upfront mortgage insurance premium (MIP) and an annual mortgage insurance premium, which helps to protect the lender in case the borrower defaults on the loan.

Overall, FHA loans can be a good option for first-time homebuyers or those with lower credit scores or limited down payment funds.

However, borrowers should carefully consider the costs and requirements of the loan before applying.

Eligibility Requirements for FHA Loans

To be eligible for an FHA loan, you’ll need to meet certain requirements, designed to help ensure that borrowers can repay the loan and keep their homes:

• An FHA-approved appraiser must appraise the home
• FHA loans can only be granted for a home that will be your primary residence and not a second home or investment property
• You need to take occupation of the home within 60 days
• The home must be inspected and meet the minimum property standards

It’s important to note that these are general guidelines and specific eligibility requirements may vary depending on the lender.

If you’re unsure whether you meet the requirements for an FHA loan, it’s a good idea to speak with a lender to discuss your options.

Down Payments

The down payment required for an FHA loan is linked to your credit score. For e.g., if you have a credit score of 580, the minimum down payment is 3.5%. This is much lower than the down payment required for a conventional mortgage.

If you are able to provide a down payment of 10% then you can have a credit score of 579 or lower. However, this ultimately depends on the lender.

For e.g., the requirement for an FHA loan through Rocket Mortgage is 580.

Mortgage Insurance

With an FHA loan, you must pay a mortgage insurance premium (MIP). This is to protect the FHA in case you default on your loan.

You’ll typically pay FHA mortgage insurance for the entire period of the loan unless you’ve made a 10% down payment. In this case, you’ll pay MIP for 11 years.

You will be charged an upfront mortgage fee of 1.75% of the loan amount and you’ll also pay an annual MIP based on the duration and amount of your FHA loan. These annual payments are typically between 0.15 – 0.75% of your loan.

Income and Credit Score

To qualify for an FHA loan, you must have a steady income and be employed for at least two years. You’ll also need to provide proof of income, like your pay stubs or your tax returns.

Your credit score will determine the terms of your FHA loan and your debt-to-income (DTI) ratio plays a big role. The lower your DTI better.

According to the FHA, your mortgage payment may not exceed 31% of your monthly gross income. Your DTI should also not exceed 43% of your gross monthly income.

How FHA Loans Work

FHA loans work by providing insurance to lenders on mortgage loans. This is to protect the lender should you default on your loan.

Let’s take a closer look at how FHA loans work:

Loan limits

According to the Department of Housing and Urban Development, the maximum loan limit for 2023 for FHA loans is $1,089,300.

This limit is for high-cost areas like big metros. For low-cost areas, the loan limit for FHA loans is $472,030 for 2023.

FHA loan limits are set based on property values. You can look up values in specific areas on the FHA mortgage limit page.

FHA Interest Rates

Interest rates on FHA loans are competitive in comparison to traditional mortgages. This is because these loans are backed by the government.

The interest rate you’ll get depends on many factors including your income, down payment about, credit score, and the current interest rates.

Advantages of FHA Loans

There are several advantages to choosing an FHA loan over a conventional mortgage. Let’s take a look at some of the key benefits:

Pros

• Lower down payment requirements
• Flexible credit score requirements
• More lenient debt-to-income ratio
• Lower interest rates

The lower down payment requirement is a great benefit of FHA loans. With the down payment being as low as 3.5%, it’s easier for borrowers to qualify.

FHA loans typically rewuire lower credit scores than conventional mortgages. This means you can still qualify for an FHA loan even if your credit score is lower.

In comparison to conventional mortgages, FHA loans also have more relaxed debt-to-income ratio criteria. This implies that you can still be qualified for an FHA loan even if you have a higher debt load.

FHA loans typically also offer lower interest rates which means you may get reduced monthly installments, making it more affordable to own a home.

Disadvantages of FHA Loans

Although FHA loans have many advantages there are also a few downsides:

One of the biggest drawbacks of an FHA loan is that you’ll have to pay a mortgage insurance premium. This premium is required on all FHA loans and is typically 1.75% of the loan amount. The MIP is added to your loan balance and can significantly increase the cost of your loan over time.

FHA loans are less flexible than conventional mortgages. You might not be able to refinance your loan without first paying off the MIP, for instance, and you might not be able to make extra payments without being penalized.

FHA loans often have stricter underwriting requirements than regular mortgages. As a result, it could be harder to be approved for an FHA loan, especially if your credit score is poor or your debt-to-income ratio is high.

FHA vs Conventional Loan

Borrowers must fulfill specific criteria in order to be eligible for both FHA and conventional lending loans.

When compared to conventional house loans, FHA loans often offer more flexibility regarding the minimum credit scores and down payments.

The conditions and costs of FHA mortgage insurance differ from those of regular mortgages.

Here are the key differences:

• You typically need a lower credit score for an FHA loan to qualify for a low down payment of 3.5%.
• If you have a credit score between 400 and 479 you may qualify for a 10% down payment on an FHA.
• Although most traditional mortgage lenders require a DTI of less than 50% you may qualify for an FHA loan with a DTI of 36% or less.
• FHA loans require mortgage insurance regardless of your down payment, whereas conventional loans typically require insurance if your down payment is less than 20%.
• FHA rates are typically lower than conventional mortgage rates.
• Loan limits are typically higher for conventional loans than FHA loans, although these limits are set by regulators and may change annually.

Summary

FHA loans are a popular choice for homebuyers due to their low down payment requirements, flexible credit score requirements, and more lenient debt-to-income ratio requirements.

However, there are also some disadvantages to consider, such as the required mortgage insurance premium and stricter underwriting guidelines.

When deciding whether an FHA loan is right for you, it’s important to weigh the benefits and drawbacks and to speak with a lender to determine your eligibility and to understand the terms and conditions of the loan.